x Abu Dhabi, UAEFriday 19 January 2018

EU's challenge in Greece seems all too familiar

Greece is up to its eyeballs in debt that is equivalent to roughly 113 per cent of its economy.

It's like deja vu all over again. A debt crisis is narrowly averted in a small but significant member of a larger economic and currency union when larger members come to realise that the risk posed to the whole can be greater than the damage to any one of its parts. Why does this all seem so familiar? Now I remember: it was almost a year ago exactly that the UAE had to come to the support of Dubai, with the Central Bank buying US$10 billion (Dh36.72bn) of Dubai bonds at the height of the global financial crisis. Ten months later, Abu Dhabi and two of its banks stepped forward to assist Dubai again by buying a second $10bn of bonds, heading off what could have been another credit crisis with repercussions far beyond Dubai.

There are intriguing parallels between the predicament facing the UAE in Dubai and that facing the EU in Greece, just as there may prove to be for the US in several of its own heavily indebted states. Obviously, there are important differences in the political structures of the three - the UAE is in many ways more like the US than the EU and yet in many ways more European than American. And Dubai's particular debt situation is unique, since most of the burden of debt it faces is owed by government-owned companies and not by the Government itself.

Yet from a credit perspective, the similarities are uncanny. Dubai and Greece are both sovereign borrowers that have no currency of their own in which to borrow. Greece is up to its eyeballs in an estimated ?272bn (Dh1.36 trillion) of debt, equivalent to roughly 113 per cent of its economy. Dubai and the companies it controls have an estimated $87bn of debt, also slightly higher than the emirate's GDP.

What's perhaps most interesting, however, is the somewhat fitful process by which authorities and neighbours gradually and somewhat reluctantly become aware of the broader risks posed when markets begin speculating against the financial health of one of their number. For Dubai and Greece, the measure of this concern was reflected in the price of insuring their respective debts through credit-default swaps. Last year, with global credit markets virtually shut down, Borse Dubai was able to refinance only $2.5bn of a $3.4bn loan coming due. Its parent, the Investment Corporation of Dubai, had to come up with the remainder itself. With an estimated $13.4bn in additional debt repayments due for last year, Dubai's credit-default swaps skyrocketed. That became a self-fulfilling phenomenon: with markets speculating that Dubai would have trouble meeting its debt payments, its cost of borrowing soared, making it indeed much more difficult for Dubai to tap credit markets.

Likewise, Dubai's announcement in late November that it was being forced to step in and manage Dubai World's restructuring, which would include a request for a debt standstill, shook emerging credit markets, pushing up borrowing costs across the Gulf - even in Abu Dhabi. That, and the prospect of a contagion spreading among UAE banks with high exposure to Dubai World, such as Abu Dhabi Commercial Bank, convinced Abu Dhabi to choose the less expensive option of investing in Dubai's debt.

A similar surge in Greece's credit-default swaps presaged this weekend's move by its neighbours to support the Hellenic republic's debts. In both cases, it was clear that allowing a default by or even continued speculation about one could raise borrowing costs for everyone who shared the currency. In Europe's case, the speculation over Greece's creditworthiness had already spread to Portugal and Spain, and there was a danger it could disrupt the smooth working of the massive Eurobond market.

Similarly, Dubai's debt difficulties a year ago threatened to complicate plans by Abu Dhabi and the UAE to launch bonds of their own and so reduce the country's reliance on banks. While Abu Dhabi has ample reserves of its own, it is hard to see how its April bond sale could have gone so smoothly had the nation's financial and trading hub been in greater difficulties. In the end, it has proved much simpler for the UAE and Abu Dhabi to reach out to help Dubai than it will in Europe, serving as testimony among other things to the much closer political union between the emirates. While there are few specific laws or regulations under which such aid can occur in the UAE, there is at the same time little obstructing it. There was nothing stopping the UAE's Central Bank from investing in $10bn of Dubai bonds. Abu Dhabi's transfer of $4.1bn to Deutsche Bank in December to ensure the repayment of Nakheel's maturing sukuk was therefore a simple matter. The paperwork on its purchase of bonds from the Dubai Financial Support Fund can be cleared up later.

The European Central Bank, on the other hand, cannot buy Greek bailout bonds. Nor is the EU allowed to bail out Greece. Any financial assistance, therefore, will have to come directly from Greece's deeper-pocketed neighbours, from Germany and France in particular. When they do help, it will be interesting to see how much they adopt from the UAE's playbook. One consequence of the crisis here has been an effort to improve the co-ordination of debt, not only the creation of debt co-ordination offices at the emirate and federal level, but the imposition of limits on each emirate's respective debts.

Greece's benefactors will want to impose targets and timetables for it to get its fiscal deficit back under control. They may not have as much latitude as in Dubai to whittle down Greece's post-crisis debts to a more manageable level through restructuring, however. The fact that Dubai has been able to differentiate the treatment of its own, sovereign debt from the corporate debt of its companies is key. Creditors are still arguing that the Government funds provided to Dubai World be treated as injections by Dubai World's shareholder. The Dubai Financial Support Fund, however, insists that money it has provided to Dubai World is a third-party loan that takes precedence over previous loans in the event of a default. Dubai World's creditors don't like this: It diminishes the value of their loans. The Dubai Financial Support fund has to play it straight: Its money is a loan and loans have to be paid back.